It's A Long Winding Road....

Well the FT are reporting that negotiations for the new government are now underway, despite the obstinacy Berlusconi is still demonstrating. It does however look like the new government won't be formed until late in May since Carlo Azeglio Ciampi, Italy’s president, has the constitutional duty to swear in premiers butwants his successor to appoint Mr Prodi because his own seven-year term ends on May 18. This is the classic situation where a country would see the indecision leading to a run on its currency, but since Italy is in the Euro this can't happen. This is both good and bad. It is good as it enables people to take their time in the negotiations about the new government, and if Prodi were to be serious about trying to set up a stable government which can carry out serious reforms this time will be needed, but it may be bad if the time is just frittered rather than gainfully employed. This, of course, has been Italy's experience with the euro to date, where it has been a shield against reform rather than a stimulus for it.

The big fear is that is one day reality does burst through the shield, then the resulting correction may be a big one.

Some indication of the scale of the problem can be read from the following:

"Mr Prodi’s precarious position in the Senate will rest on the support of Communist Refoundation, a hardline party led by Fausto Bertinotti, who instigated the downfall of Mr Prodi’s previous government in 1998.

Asked by reporters if he feared a “Fausto factor” would destroy his next government, Mr Prodi replied: “There’s no Fausto factor. There’s a strong agreement.”

He was referring to the programme on which he fought the April 9-10 ballot in alliance not only with the communists but with a multitude of parties ranging from Catholic centrists to Greens and secular radicals.

An early hint of trouble emerged on Wednesday when 12 dissidents in Communist Refoundation threatened to split the party and go into opposition if the party leadership supported a Prodi government.

In a statement, the dissidents said a Prodi-led government would be “anti-worker” and founded on “a programme of blood and tears” dictated by Italian big business."

Essentially, to make an effective reform government Prodi needs to reach across the divide, and find some points of support among some of the moderate centre right members of the 'House of Freedoms'. Failing that it is hard to see how his government can work given Italy's important economic problems.

These are nicely outlined in an article in Business Week today:

Prodi's urgent first task will be attacking Italy's spiraling budget deficit, which could hit 4.5% this year and its towering national debt, which has been rising steadily for two years and is headed for 107% of gross domestic product. That means curbing government spending and raising new taxes pronto. But those are hardly popularity-enhancing moves. The task is all the more difficult with Italy's economy forecast to grow at a feeble 1.2% in 2006.

The question is, how much capital will Prodi have to spend on such belt-tightening moves just to stabilize government finances, before he can even begin to tackle economic reform? Given his razor-thin majority in the Senate, tough measures are likely to prompt political infighting. Far left coalition partners, including two communist parties, make up nearly 10% of Prodi's support base. And firebrand communist leader Fausto Bertinotti is once again an ally despite having torpedoed Prodi's 1998 government.

One of the biggest reform challenges facing Prodi will be injecting greater flexibility into Italy's rigid labor market. Like France, where massive protests reversed passage of a law that sought to encourage companies to higher younger workers by making their employment terms more flexible, Italy already has a large number of workers employed through temporary contracts.

Italy's labor market remains extremely rigid because the country lacks a comprehensive unemployment insurance system. Government payouts to laid-off workers are decided on a case-by-case basis and tend to only cover larger companies. That makes routine restructuring at the bulk of smaller companies -- which comprise 70% of the Italian economy -- nearly impossible. "It's a major obstacle to restructuring," notes labor expert Boeri.

Prodi's platform also includes a plan to create a kind of "tenure track" for workers, which would help them clinch a job on a flexible contract that over time adds increasing protections for the worker. The idea is not to create a new labor contract for the disenfranchised, as France tried, but to adjust the existing contract in a way that would permit companies to hire workers on a flexible basis and compel them to grant an increasing amount of protection over time.

Economists also point to reforms that would not cost the government anything but would unleash fresh competitive energy in Italy's economy, such as liberalizing Italy's high-cost service sector including energy, transportation, communication, retail trade, and a variety of professions. The idea is to rid the system of guild-like rules that have their origins all the way back in the Middle-Ages.


Well, much of this sounds interesting in theory, seeing it in practice though will be what is important. The bottom line is that I cannot avoid the feeling that Italy has an extremely tough time ahead of it. I would, of course, wish to be proved wrong.